The Tax Court held that based on the facts and circumstances a decedent, who had been actively and significantly involved in managing a group of companies, did not have an ownership interest in the companies at his death for estate tax purposes.
Robert Fortunato (Bobby) was a colorful character and a talented manager and business strategist in the warehousing business, with a penchant for living the high life and a strong-willed personality that caused him to “seek and find trouble.” After serving a six-year stint in Sing Sing prison, he went on to form a highly successful export business. However, due to financial misappropriation and ill-advised high-interest borrowing, the business failed, leaving Bobby deeply in debt. For a time afterward, Bobby essentially went into hiding at his parents’ home, refusing to open a bank account or sign any documents to avoid his creditors.
In 1984–1985, Anthony Fortunato, Bobby’s younger and more responsible brother, started a container freight station (CFS) and bonded warehouse business in New Jersey called St. George Trucking and Warehousing (St. George NJ). Anthony’s father and another of the Fortunato brothers, George, were co-investors. Because of Bobby’s past experience and business acumen, Anthony brought him into the business. Bobby soon assumed de facto leadership of St. George NJ, but he held no business title and was not on the payroll. In order to pay Bobby for his work while keeping his role in the business secret from both his creditors and the government, St. George NJ made payments to a fictitious person, cashed the checks, and put the money in the company’s safe for Bobby’s use. Despite his substantial involvement in the business, Anthony and his father did not transfer any legal ownership interest in St. George NJ to Bobby.
At Bobby’s instigation, Anthony (with several other investors) opened a subsidiary company in Southern California (St. George CA) to take advantage of the burgeoning West Coast import business. Soon after, Bobby moved to the area and took over all aspects of St. George CA’s management. Under his leadership, St. George CA was extremely successful, and the company paid him handsomely (albeit clandestinely) for his efforts. Once again, Bobby held no official title in the company and did not have a legal ownership interest in it. However, at various points in time, Bobby held himself out as either the owner of St. George CA or a partner with Anthony in the company. Because of this, many parties outside St. George CA believed that Bobby was at least a partial legal owner of the business.
Anthony later opened a second subsidiary in Atlanta, Georgia (St. George GA). In 2000, Anthony (who had bought out the other investors in the St. George companies) began actively considering a sale of St. George CA and eventually all the St. George companies. A large payout to Bobby from the sales proceeds was discussed, but Bobby did not like the proposed buyer and killed the deal by refusing to remain with St. George CA after the sale. In 2002, Bobby changed his mind about keeping his role in St. George CA a secret and contacted the subsidiary’s bank about getting a loan to buy out Anthony. However, before he presented an offer to Anthony, Bobby died.
The Parties’ Arguments
The IRS, for estate tax purposes, claimed that Bobby, although he did not have a legal ownership interest in the St. George companies, had in fact cofounded the companies and owned an interest in each of them (50% in St. George NJ and St. George CA and 25% in St. George GA). The IRS argued that Bobby avoided taking a legal interest in the companies only because doing so would expose the interest to his many creditors and cause the company problems with government authorities due to his prior criminal convictions. The IRS further alleged that the way the companies were operated, with Bobby developing business strategy, directing employees, controlling the finances (including using the companies as his personal “piggy bank”), and sometimes holding himself out as owner to customers and vendors, was evidence that Bobby was actually a part owner of the companies.
Bobby’s estate claimed that Bobby did not own an interest in either the original company or the subsidiaries. The estate asserted that because of Bobby’s past financial and legal problems, he never intended to and never did own an interest in the St. George companies. Although he did work for the companies, the estate noted that the companies had paid him generously for his services.
The Tax Court’s Opinion
The Tax Court held that Bobby did not own an interest in the St. George companies for federal estate tax purposes. The court explained that while state law creates legal interests and rights, federal law designates which of those interests and rights will be taxed. In determining whether the state law in question created a taxable interest for federal tax purposes, courts may look through the formalities of the law to the substance of the situation. Because Bobby clearly had no formal legal interest in the companies, the Tax Court looked at the surrounding evidence to determine whether Bobby had shown an intent to be an owner of the St. George companies and whether the companies had shown an intent that he be an owner. Ultimately, the Tax Court found no intent on either side that Bobby be an owner.
The Tax Court found that Bobby had no desire to be an owner due to past financial and legal problems. It also noted that he was well compensated for his work, so he had no financial reason during his life to be a shareholder, and that he was estranged from his wife and children, so he had no reason to want an ownership interest to pass along to others at his death. The Tax Court further found that Bobby had never made capital contributions to the companies or guaranteed their debt and had no risk of loss in the companies. Thus, it held that Bobby had no intent to be a shareholder in the St. George companies.
From the perspective of the companies, although Anthony (the primary owner of the companies) clearly wanted to have Bobby working for the companies due to his business skills and acumen, he was also clearly aware of the problems that Bobby might present as an owner. Therefore, the Tax Court refused to equate the desire to have Bobby as an employee of the companies with an intent to have Bobby as an owner.
The Tax Court also disregarded Bobby’s involvement in the negotiations for the sale of the companies as evidence of his status as an owner. It found that it was normal for a person with his level of involvement in the companies to be intimately involved in any sale discussions. It further found that given his relationship to Anthony, it would not be unusual for him to receive some of the sale proceeds even though he was not an owner.
In this case, the IRS seems to have forgotten that when making a substance over form argument, there must actually be strong evidence to support the substance that is being claimed. The peculiar baggage that Bobby Fortunato carried with him clearly made it advantageous for all the parties involved that he not be an owner of the St. George companies. Thus, the form of Bobby’s relationship with the companies (no legal ownership interest in them) was in line with the substance of the relationship.
Estate of Robert C. Fortunato, T.C. Memo 2010-105